Before the current, rather liberal, tax advantages for homeownership, many older people delayed or declined marriage or remarriage "for tax purposes."
That’s because each individual over 55 was entitled to a one-time tax exclusion of $125,000 on the sale of a principal residence.
Because many former spouses entered into a new relationship already owning a home, they usually chose to sell one of them before returning to the altar. That way, they could obtain the $125,000 benefit twice; a married couple got it only once.
I thought about that "marriage penalty" recently when the U.S. Tax Court ruled that the cap on mortgage interest deductions applies in the same way to unmarried couples as it does to married couples, affirming a ruling by the Internal Revenue Service assessing a tax deficiency against a gay couple who jointly own two houses.
The court rejected the petitioners’ argument that Congress intended to impose a "marriage penalty" on married couples.
Under the Internal Revenue Code, mortgage interest is deductible from income, but not to the extent that it is attributable to an outstanding mortgage principal balance of more than $1 million. Similarly, interest payable on a home equity line of credit that is used to finance home improvements is deductible, but not to the extent that it is attributable to an outstanding loan balance of more than $100,000.
In this case, the same-sex couple jointly purchased houses in areas of Los Angeles and Palm Springs. They used the Palm Springs house for vacations and weekends and the L.A. home as their primary residence.
The outstanding mortgage principal balances for the two houses exceeded $2 million in 2006 and 2007, and the outstanding principal balance on a joint home equity loan exceeded $200,000.
In filing their federal income tax returns for 2006 and 2007, they each claimed interest deductions for interest attributable to a $1 million mortgage balance and $100,000 home equity loan balance, effectively asserting that each could use the full interest deduction allowance.
According to the case, the IRS sent both people deficiency notices, disallowing a substantial portion of their interest deductions. It maintained that the $1 million and $100,000 caps were applied per residence, not per taxpayer.
The IRS pointed out that a married couple jointly purchasing a house is subject to the $1 million and $100,000 cap, even when the married couple files their income tax returns separately (in which case, each can claim deductions only for interest attributable to half the capped amounts).
And, in a prior case, the IRS had taken the same position regarding unmarried different-sex couples who purchased houses jointly.
Which takes us back to the benefit of owning (not necessarily filing) separately especially when it comes to deducting mortgage interest on expensive homes.
The Taxpayer Relief Act of 1997 changed not only the one-time, $125,000 home-sale exclusion for persons over 55 years of age, but also the "rollover replacement rule." Under the old law, a taxpayer could defer any gain on the sale of a principal residence by buying or building a home of equal or greater value within 24 months of the sale of the first home.
Tax on the gain was not eliminated, but merely "rolled over" into the new residence, reducing the tax basis of the new home.
The intent of the 1997 tax code, which replaced the "rollover" provision and $125,000 over-55 exclusion, was to allow most homeowners to sell their primary residence without tax — and not worry about keeping records. Taxpayers no longer can utilize parts of either portion.
In order to qualify for the $250,000 exclusion ($500,000 for married couples), taxpayers must have owned and used the property as a principal residence for two out of five years prior to the date of sale.
Second, they must not have used this same exclusion in the two-year period prior to the sale. So, the only limit on the number of times a taxpayer can claim this exclusion is once in any two-year period.
Next week: The biggest deduction many homeowners take is often too much.
Tom Kelly’s new e-book, "Bargains Beyond the Border: Get Past the Blood and Drugs: Mexico’s Lower Cost of Living Can Avert a Tearful Retirement," is available online at Apple’s iBookstore, Amazon.com, Sony’s Reader Store, Barnes & Noble, Kobo, Diesel eBook Store, and Google Editions.
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